Southern European banks headed north

One of our highest conviction views this year so far is that subordinated debt issued by southern-European banks is an attractive place to be invested. We are seeing bottom-up improvement, helped by regulatory zeal that still works in favour of bondholders versus shareholders, as well as a very strong technical picture.

In Spain we believe that the system as a whole is ripe for a rapid acceleration of real estate asset disposals by the local banks. We saw early signs of this trend in 2017, when Banco Santander and BBVA closed on large-scale transactions to remove the real estate risk from their balance sheets. We are of the view that this trend is not specific to these two names, but will spill over to the rest of the local banks.

In Italy we see the recovery as less-systemic and wide-spread versus that of Spain; nevertheless, the top two players have in our view improved sufficiently enough to turn the page in their credit recovery stories too, even if the challengers in Italy still have work to do.

From a regulatory point of view, there is a strong impetus to tackle the still high stack of bad loans in the periphery. Even without official targets, we see all Italian banks (bar UniCredit, which is already one step ahead) coming out of full-year 2017 reporting periods with updated three-year targets to halve the total stock of bad loans. This is quite a change in narrative versus the previous tone from local bank managers, and there is little doubt (in our minds) that this is a result of a close interaction with the central regulators as of late.

Broadly speaking, we have reached a turning point in the recovery cycle in Spanish (and partially Italian) banking systems. At the face of a stringent regulator, we reasonably expect that on one hand, the progress in credit health is solid enough to justify an overweight position, while on the other we still see ample room for balance sheet improvement. Therefore, unlike most northern-European banks, we continue to expect that the improving health of these financial institutions continues to accrue more to the benefit of creditors versus that of shareholders.

This means that from an investing point of view, we are very comfortable taking subordinated credit risk in the two markets. We continue to see the combination of a) a very strong technical picture in the asset sub-classes and b) the rapid improvement in fundamentals as not properly reflected in bond yields (versus comparable core European peers).

As always, good active management and strong issuer and credit selection will be key to optimising total returns in this space.

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For Professional Investors only and not to be distributed to or relied upon by retail clients.

The opinions presented are those of Kames Capital fund managers as at the time of publishing and may change as subsequent conditions vary. They are not intended to be relied upon as a forecast, research or investment advice, and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Companies mentioned may not necessarily be held in any of Kames Capital funds. The information and opinions contained in these pieces are derived from proprietary and non proprietary sources deemed by Kames Capital to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. Reliance upon information in this material is at the sole discretion of the listener/viewer.

This site is not intended for use by any US persons (being residents of the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof), who are excluded from the content in this site.